Monday, December 13, 2010

Revenue-Based Financing

In the last week I've had three exposures to a type of financing I honestly had never heard of. I know, it's hard to believe. Seriously, although I like to consider myself knowledgeable of the myriad types of financing available, I know I don't know them all. And, just as creativity is applied to other business aspects, creativity can be and is applied to the finance realm. (NO, I'm NOT speaking of fiddling with your numbers but of taking a creative approach to solving a problem or resolving an issue. In this case, the issue is financing your company's growth.)

The "new" type of financing I've recently learned of is called revenue-based financing. Revenue-based financing, also called royalty financing, is repaid based on a percentage of revenue, typically 2-6% of gross revenue, on a monthly basis. Since revenue can fluctuate month over month or year over year, revenue-based financing has variable payments. This variability makes it attractive to rapidly growing small businesses that do not have predictable cash flow, operating profits, or even gross revenues. For example, gross monthly revenue may be deal-dependent and therefore chunky.

Unlike a bank loan, repayments are capped like some hybrid (blended equity and debt) investments. The cap is usually 2x - 5x the total principal investment amount. If the original investment was $200,000, then the repayment will be $400,000 to $1,000,000. The repayment is based NOT on an interest rate but on the specified cap amount. Unlike the typical bank loan, there is usually no personal financial liability (i.e., no personal guarantees required) and the financing documentation is usually covenant light. This means that there are few onerous financial maintenance requirements for the business. Like a bank loan, the financing  may be secured by business collateral. Unlike a bank loan (except those provided by banks like Silicon Valley Bank which often lend to technology and biotech firms), intangible assets may comprise the bulk of the collateral.

Lastly, due to the large variability in revenue, typically the deal size is a relatively small percentage of revenues, usually 10-25% of historical revenue.

On Wednesday I'll provide an example to help illustrate how and when revenue-based financing is used. I'll also provide a table comparing it to typical bank loans.
FYI 


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